Second Circuit: Insider Trading Duty is Federal Common Law

The Second Circuit Court of Appeals concluded that an Exchange Act Section 10(b) claim for insider trading in a private damage action is based on federal law and applies to the purchase of shares of a delisted company by corporate insiders. In reaching this conclusion the Court relied on the classic theory of insider trading, finding the misappropriation theory inapplicable. Steginsky v. Xcelera, Inc., Nos. 13-1327-cv; 13-1892-cv (2nd Cir. Jan. 27, 2014).

Plaintiff Gloria Steginsky is a former minority shareholder of Xcelera Inc., a Cayman Islands holding corporation based in Connecticut. Each of the individual defendants is an officer and or director of Xcelera: Alexander Vik, is COB and CEO; Gustav Vik, Director, EVP, secretary and treasurer; and Hans Erik Olav is a director. The two corporate defendants are controlled by the Vik defendants. VBI Corporation, owned by Alexander Vik and Erik Vik (Gustav’s father) is the controlling shareholder of the firm. OFC Ltd. was created in 2010 by the Vik defendants as a vehicle to acquire the share of Xcelera.

The complaint alleges that the shares of Xcelera were at one time listed on the American Stock Exchange. In 2000 the shares traded at prices as high as $110 per share. In 2004 when the price plummeted the Vik defendants began refusing to make the required periodic filings with the SEC. Since 2005 the defendants have not disclosed any information regarding the company. The next year the Commission revoked the registration of the firm. The share price dropped to $0.25.

Subsequently, investors were told they could sell their shares back to the company. In December 2010 OFC made a tender offer for Xcelera shares at $0.25 per share. While the offer was made by Olav, the complaint clams that it was orchestrated by the Vik defendants. In April 2011 plaintiff sold her 100,100 shares of Xcelera common stock to OFC.

Plaintiff filed a complaint alleging a series of claims including violations of Exchange Act Sections 10(b) and 14(e). The district court dismissed the complaint.

The Second Circuit affirmed the dismissal of a market manipulation and Section 14(e) claims while vacating the dismissal of the insider trading claim under Section 10(b).

First, the market manipulation claim is time barred the Court ruled. A securities fraud claim must be filed not later that the earlier of either two years after discovery of facts constituting the violation or five years after that violation. Here the alleged manipulation was the failure to make SEC filings which caused the price to plummet. That began in 2004, more than five years before the complaint was filed.

Second, plaintiffs can assert a claim for insider trading under Section 10(b). Under the classic theory of insider trading Section 10(b) is violated when a corporate insider trades in the securities of his or her company on the basis of material, nonpublic information. To establish such a claim it is not necessary to demonstrate that the insiders used the nonpublic information. Rather, it is sufficient to prove that the person traded while knowingly in passion of it. Likewise, the plaintiff need not prove reliance where, as here, the necessary nexus between plaintiffs’ injury and the wrongful conduct is established by the breach of a duty to disclose.

The complaint in this action alleges that the defendants, while in control of the company, purchased the shares without disclosing any information about the firm. That is adequate under the classic theory – the misappropriation theory, which “targets non-insiders, is not applicable here.”

The district court’s conclusion that the defendants had no duty to disclose under the circumstances here because the shares are not registered and Cayman Island law governs the company is incorrect. The “duty of corporate insiders to abstain from trading or to disclose material inside information applies to unregistered securities . . .” since Section 10(b) by its plain terms applies to “any security registered on a national securities exchange or any security not so registered.” (emphasis original).

Furthermore, the duty of insiders is derived from federal common law, not state law. The Court held that while it had not previously identified the source of the “the fiduciary-like duty against insider trading under section 10(b) . . . [it is] defined by federal common law, not the law of the Cayman Islands.” Thus here, while the defendants had no general affirmative duty to disclose once Xcelera was deregistered by the SEC, “they could not trade in Xcelera shares based on undisclosed material inside information that they possessed.”

Finally, the Court affirmed the dismissal of the Section 14(e) claim. That Section and the related rule provide that if any person has taken substantial steps toward a tender offer it is unlawful for another person who is in possession of inside information relating to the tender offer to trade. In this instance, however, the complaint alleges that not that someone possessed inside information about the tender offer but that the offer itself was made by corporate insiders who possessed material nonpublic information. Accordingly, the Court remanded the Section 10(b) claim to the district court.

Latest Posts

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

"My best business intelligence, in one easy email…"

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.

Privacy Policy (Updated: October 8, 2015):

hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide

*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.